PostThu May 19, 2016 6:32 pm
In March, I wrote about how the bitcoin halving event, which will occur in early July, is likely to have a negative impact on bitcoin and to cause significant disruption in the cryptocurrency industry. I predicted that of all the possible scenarios, the most likely outcome was Ethereum taking over the role as the #1 cryptocurrency. I later updated the predictions in April, at which time I said that I would post another update in late May. In this update, I'll review how these predictions have continued to bear out as stated, and why the landscape is going to be dramatically different in a few months. If you have not already done so, you should review the original post at viewtopic.php?f=11&t=782 before continuing.
While I don't trade cryptocurrency and we have recently been selling all our profits to dollars, I do believe that price is the most accurate representation of the demand for and potential of a technology. Using price as an indicator isn't perfect - bubbles come and go all the time - but price is useful because it is forward-looking. There is a huge difference between news articles where rich community figures state what they believe, and people who actually put their money on the line to cover their beliefs. If I am an average worker who earns $37,000/yr and gets taxed 20%, then my buying $2466 of bitcoin implies that I believe in the technology so much that I'm willing to have gone to work for no reason at all for an entire month - time that could have instead been spent relaxing at home - if bitcoin doesn't work out.
Work being so hard is why political prediction markets are consistently far more accurate than polls. Trump may now be favored to win in the latest polls, but prediction markets think his odds are only 42%. When people risk having put in hard labor for nothing, they often take more time to do research and ensure what they believe is correct. Thus, looking at the price of a coin is far more valuable than reading general sentiment on the Internet about that coin.
Examining prices and comparing them to the March predictions, we can see that bitcoins are worth less than I believed they would be at this point, and ether is worth more than I believed it would be. Perhaps the most striking difference from the original charts in outcome C is that bitcoin never reached the $600 bubble that I believed naive investors would inflate around Memorial Day. Since there is no shortage of low-information institutional investors around bitcoin, the reasonable conclusion to draw is that the investors are there, but the natural price limit for the number of transactions that can fit in 1MB blocks is $470. Every time price reaches $470, blocks become overloaded and price retreats again. Now, blocks remain overloaded even though the bitcoin price fell, suggesting that the decline will continue without price returning to $470 again.
It is important to note that while the halving will cause miners to go offline and there will be long block times and network disruption as a result, the crash in bitcoin is likely to occur before the halving because market crashes are usually caused by panic. People will get out because they are worried that their funds will be frozen after the block reward halves, and they will do so far enough in advance to be assured that their money is secure. Anticipation of problems is why the the bitcoin crash is likely to begin within a few weeks (the previous article predicted decline starting around Memorial Day), not the day after the halving. Even if the halving does not cause a single miner to go offline, people know that there is no chance that the blocksize will increase by then, and they will not be willing to risk the chaos that could happen. For example, there were over 50m bitcoin days destroyed yesterday, the highest daily total ever, so somebody moved a lot of coins that were in cold storage to prepare for something.
In the previous articles, I explained why Segregated Witness would be unsuccessful at alleviating network congestion because there was little reason to adopt it for big corporations with high risk and the claimed 4x capacity increase was impossible with most transactions. But I had assumed that the Core would meet their deadline of releasing Segregated Witness's code by April, which they failed to do. Given that it has already been an entire month since the feature was promised to be released, the odds that a significant fraction of the network will adopt it before July are very low. Another issue with Segregated Witness that receives little mention is that the Core has continued with development of controversial features, like replace-by-fee, which are now bundled into all Core builds. Only a third of the network runs the 0.12 Core builds that include these features even months after they have been released (and several updates have been made available too). Some people who like Segregated Witness may not adopt it simply because it initially won't be separable from other features they oppose.
Ethereum, on the other hand, has started its rise more quickly than I believed it would. I had not anticipated that actual uses for the Ethereum network would arrive so quickly. While it's impossible to determine conclusively the cause for any market movement, The DAO has brought in hundreds of millions of dollars into Ethereum in just 20 days. The unprecedented success of The DAO suggests that much of the current Ethereum rise is not caused by speculation. Unlike with speculative buying, ether that goes into The DAO is unlikely to go back out because the quorum for The DAO is so high that tokenholders will not be able to agree to spend it. DAO ether is effectively "locked up" for the long term.
If most of the current rise is due to The DAO, it's possible that the current Ethereum price, or a level very close to it, is the floor for future valuation. Once money starts coming in around the bitcoin halving, it could skyrocket even further with the speculative investments adding to the money locked up in The DAO. And future DAOs that improve upon the quorum requirements of the first one, may lock up even more ether. Some believe that the majority of ether will eventually become controlled by The DAO or other DAOs. I did not anticipate the possibility or timing of DAOs earlier and it is one of the reasons I am more confident that Ethereum will overtake bitcoin now than I was before.
One of the biggest reasons that Ethereum will benefit is that it is far easier to trade bitcoin for Ethereum than it is to trade bitcoin for dollars. When the bitcoin panic ensues, bitcoin holders who don't have the ability to set up a bank account link, or who are worried about the time it takes to do so, can easily transfer bitcoins to Poloniex and change it to ether. In fact, a significant rumor has popped up that Coinbase will add Ethereum trading. If true, this feature has profound implications because Coinbase had talked about litecoin integration for years, never saw litecoin as worthy of trading, and now sees Ethereum as worthwhile to offer. Coinbase offering Ethereum trading would also be an enormous event because Coinbase controls 10% of the entire world's bitcoin reserves. During the halving event, the bitcoin network could become completely unusable and up to 10% of all bitcoin would still be able to be sold into Ethereum without issue.
At this point, Bitcoin has been, as businesspeople often say, overcome by events (OBE). Only an unprecedented step will save bitcoin from losing its place as the #1 coin. Consensus conferences, further negotiation, and Bitcoin Classic no longer have enough time to succeed. Those who see value in saving bitcoin need to release a client that will hard fork the chain on the day of the halving to support 2MB blocks, using merge mining, regardless of consensus. This is the only way to give owners of bitcoin a say. Force miners to make a choice of forfeiting revenue by not merge-mining the new chain, and force exchanges to give up revenue by not trading the new chain. Some miners will mine or merge-mine the new chain, and some exchanges will trade it, and the question of whether normal bitcoin holders support larger blocksizes will be answered once and for all by the markets. A final decision on the issue needs to be forced, now, if bitcoin users want to save their network. If the chaos causes both forks to crash to equal value, that indicates that the deadlock is so entrenched that a fresh start with Ethereum was inevitable anyway. Myself, I'm not convinced that effort should be spent on this because it implies that bitcoin is worth saving despite Ethereum already being better in most ways. There aren't yet enough critical services running on bitcoin, and talent like Andresen and Garzik who think that cryptocurrency has to grow soon could instead be spent further improving Ethereum.
Based on happenings since I wrote the March article, almost all of the short-term news for Bitcoin has been negative, and almost all of the short-term news for Ethereum has been positive. Bitcoin has had no progress on the block size problem, Segregated Witness not only won't have much of an impact but it also isn't anywhere to be found, Craig Wright was able to further sideline Gavin Andresen as a bitcoin developer, miners are unwilling to adopt alternate implementations, Bitcoin lacks a vision, and the Thunder network requires forks to implement prerequisites that will be no less controversial than the one already under consideration. Ethereum has executed the most successful crowdfunding effort in history, multiple major exchanges have started trading in Ethereum, and its development towards its clearly defined vision continue. I see no reason why I should change my "outcome C" prediction, which remains that Bitcoin will have a major crash within two months and that Ethereum will see dramatic adoption across all exchanges and businesses to become the dominant cryptocurrency over the next year.
